Filing Taxes After a Divorce

The first step to filing your taxes after divorce or legal separation is to determine your filing status. If you’re going through a divorce, it can be tricky to know whether you should file as married or single.

The IRS stipulates that if you are separated but have not obtained a final decree of divorce before Dec. 31 of the tax year, you must file as a married person — either jointly or separately — at tax time. If you are considered legally separated or divorced by Dec. 31, you should file as a single person for that tax year.

Before you go to file your taxes after a divorce, ensure that your Form W-4 is updated to reflect your current marital status since it tells your employer how much tax to withhold from your paycheck. When you get divorced, you and your previous spouse must update your Form W-4s to reflect the change in marital status. You’ll have to get the updated form to your employer within 10 days after the divorce or separation is filed.

After two parents are divorced, only one of the parents can claim their child as a dependent. Generally, the parent with whom the child lived for more nights during the tax year — known as the custodial parent — claims them as their dependent.

The noncustodial parent can claim the child as a dependent if certain conditions are met. In most cases, the custodial parent must sign a written declaration that they won’t claim the child as a dependent for that tax year. This generally makes financial sense when the noncustodial parent is in a higher tax bracket and can make use of available tax credits.

After a divorce, you or your spouse may be required to pay alimony or child support. The IRS does not consider child support payments as taxable income or as tax-deductible expenses. So, if you’re paying child support, you cannot deduct that expense from your tax return. If you receive child support, you should not include child support payments when calculating your gross income.

Alimony payments may be considered taxable income or a deductible expense depending upon when the divorce was finalized. Alimony payments for a divorce executed on or before Dec. 31, 2018, are deductible by the payer and taxable to the recipient. If your divorce was executed after Dec. 31, 2018, alimony payments are not considered taxable or deductible.

Divorce often involves splitting up joint accounts and property that are owned by both spouses. This transition can have a big impact on both your personal finances and your taxes.

Selling a House

Many divorcing couples decide to sell their marital home after a divorce. You may have to pay capital gains tax depending on how you choose to go about selling the house. The gain, in this instance, is defined as the selling price, minus associated selling expenses and adjusted basis (the price paid for the home or the price to build it, with improvements and tax benefits factored in).

If you and your spouse sell the house together, capital gains tax applies — but you and your spouse can each exclude $250,000 of the gain from selling the house from your taxable income if the home was considered a primary residence. Keep in mind that this exclusion may be reduced if you bought the house less than two years ago.

If your spouse wants to buy you out of the house, you won’t have to pay capital gains tax on the sale if it’s part of the divorce settlement. If you are buying out the house from your spouse and later decide to sell it, you will owe capital gains tax on that sale and will only be able to exclude up to $250,000 of the gain.

If you continue to own the house together after the divorce, but one spouse is not living in the house, you may only be able to exclude $250,000 of gain when the house is sold. However, if you have written documentation proving that this arrangement was part of the divorce settlement, the nonresident spouse can still claim an additional $250,000 exclusion.

Splitting Retirement Accounts

Couples who have shared retirement accounts may be required to divide their accounts or negotiate a compromise to split the assets equally in a divorce. Which approach you should take and how it will affect your taxes depends on the type of retirement account you have.

Divorcing spouses with a joint 401(k) or pension must file a court order called a Qualified Domestic Relations Order (QDRO) to divide the account. Dividing or liquidating the account could involve penalties and have consequences on your taxes, so you may be better off rolling over the 401(k) into an IRA or agreeing to keep the account in exchange for an asset of equal value. A competent divorce lawyer will guide their client to negotiate an amicable outcome that makes sense for them and their finances.

Splitting up assets held in an IRA tends to be more straightforward. Both Roth and traditional IRAs can be divided using what’s called a transfer “incident to divorce.” Using this method will make sure you don’t have to pay penalties or taxes on the funds being transferred since the withdrawal of money from the account is part of a divorce settlement.

If you need to divide up an annuity in a divorce settlement, the most tax-friendly way to do so is to withdraw from the annuity and start two new annuity contracts (one for each spouse). The IRS considers this type of transfer to be a non-taxable event, so it won’t result in paying more taxes. You could also sell your annuity or surrender it and distribute the money you receive, but you may have to pay income tax on that money.

Getting a divorce is a complicated and costly process, but there are some tax breaks you might qualify for when you’re no longer married. For example, filing as head of household can mean you get a larger standard deduction from your total tax liability.

If you can claim a child as a dependent, you can take advantage of the Child Tax Credit to increase your tax refund. For the 2021 tax year, this credit is worth up to $3,600 per child ages 5 and under and $3,000 per child ages 6 through 17.

Even if you’re considered the noncustodial parent, you may still be able to claim the credit as long as your ex-spouse signs the waiver agreeing not to claim a credit for the child on their tax return. Additionally, a divorced parent who continues to pay their child’s medical bills can deduct those bills as medical expenses, even if this parent does not have custody of their child.

Alimony payments may be considered taxable income depending on the timing of your divorce settlement, but if this is the case, the taxable alimony counts as compensation to allow you to contribute to an IRA. Typically, taxpayers must have earned income from a job or self-employment to contribute to an IRA, but taxable alimony provides an exception to this rule.

It’s best practice to consult a financial advisor or another tax professional who can help you make sense of the many guidelines surrounding tax implications after divorce.